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Entrepreneurs Beware of Internal Fraud Schemes

August 20, 2010 — sbbcentcom

Just when many small business balance sheets are reeling due to the struggling economy, a hidden threat to profits could be lurking in the back office. Internal fraud has been on the upswing since the recession began. According the Association of Certified Fraud Examiners (ACFE) misappropriations and other forms of fraud have hit small businesses at a disproportional higher rate than larger concerns. If we consider that often time entrepreneurs lack the know-how (or the sufficient bandwidth for that matter) to put in place appropriate financial controls to prevent or detect fraud, you understand why they’re being taken to the cleaners more frequently. As you might imagine the theory of cause and effect is at play here, since mounting job losses and eroding safety net act as motivation for dishonest and trust unworthy employees to wreak havoc on your hard-earned profits.

The following article from the WSJ describes the plight of two small business owners and the fraudster (You guessed it, trusted insiders) that almost cause their businesses to cave in. Learn how they felled prey to these fraud flunkies and the price they had to pay. There are important lessons on two key prevention strategies: vigilance and separation of duties.

If you’re delegating responsibility for accounts receivable and the company’s disbursements, don’t put the same person in charge of both, even if it means you have to hire an additional employee.

Bring in an outside accountant at least once a year to review your business financial records. Typical fees are $100 to $150 an hour, depending on how organized your records are. Consider retaining different outside accountants occasionally to have a fresh eye involved in the review.

Be aware of employees who are involved with your company’s finances and never take time off. Embezzlers rarely take vacations for fear their theft will be discovered by someone filling in.

Embezzlers usually spend the money they steal very quickly. Tip-offs include changes in lifestyle such as spending on expensive cars and vacations.

One common internal fraud is kickbacks involving vendors, so stay alert to unusually close relationships between employees responsible for finances and suppliers and customers.

Be the first person to open your monthly business bank statements. Even if you don’t have time to examine them closely, your attention sends a message to any potential fraudster.

When perusing your bank statements, don’t just look at the numbers; examine the actual images of canceled checks. Otherwise you can’t confirm where the money really went.

Remember that some internal theft doesn’t leave an audit trail.

For example, skimming involves stealing a company’s cash before the receipts are entered into the accounting ledger. In a sales skim, the fraudster collects a customer’s payment at the point of sale and simply pockets the money without recording it. The loss may come to light only via clues such as inventory shortages or lower-than-expected cash flow.

Look at receipts for deposits of both federal and state taxes.

Remember that liabilities can double the amount of taxes due, including penalties and interest, within a year, so don’t take more than a few months between your informal audits.

Maintain an open-door policy that encourages employees who have suspicions about misappropriations or questionable spending to tell you in confidence.